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FRAUDULENT TRANSFER OR CONVEYANCE – SECTION 548

IMPORTANT: THIS FIRM MAKES NO REPRESENTATIONS AS TO THE ACCURACY OR CURRENT STATUS OF ANY LAW, CASE, ARTICLE OR PUBLICATION CITED HEREIN OR LINKED TO.  WARNING – SOME OF THESE REFERENCES ARE PRE-BAPCPA.

NOTE: THE FOLLOWING BLOG REFERENCES NEW YORK, BUT THE TERMS AND DEFINITIONS APPLY NATIONALLY.  

PREFERENCES VS FRAUDULENT CONVEYANCES IN NEW YORK: WHAT’S THE DIFFERENCE?

For New Yorkers involved with the bankruptcy process, whether debtors or creditors, the concepts of “preferences” and “fraudulent conveyances” often cause confusion.  (Actually, it’s not just laypeople.  They cause for confusion for many law students and even some lawyers as well.)

They cause confusion because they both often relate to attempts by debtors to keep certain assets from being dealt with in the bankruptcy process.  So here’s the nutshell version of the differences between the two:

Preference:

A preference relates to a specific creditor.  A debtor (often a business debtor) wants to make sure that a certain creditor wants to get paid in full before the debtor files their bankruptcy case.  Perhaps it’s an important business relationship, or a supplier with whom the debtor is friendly.   The result would be that that creditor gets 100% of their money back rather than a pro rata share.

However, the bankruptcy process is about having an orderly process for protecting creditors as much as it is about protecting debtors.  And paying a preferred creditor back ahead of the filing means that the other creditors get paid back less as a result.  So the bankruptcy law says you can’t prefer one creditor over another.

Specifically, if a debtor makes any payment to a creditor during the 90-day period prior to the bankruptcy filing, and that payment is not within the “ordinary course of business” (e.g., a payment you make regularly for supplies you need to conduct your business), then the trustee can initiate a “preference action” to undo that transaction, take the money back from that creditor and put it into the bankruptcy estate to be divided equally among creditors.  Additionally, if the creditor is an “insider” (e.g., a family member), then the pre-filing period increases from 90 days to one year.

Preference actions may be familiar to many businesses who have dealt with a company that filed for bankruptcy.  Trustees often cast a wide net, initiating preference actions against many creditors and suppliers in an effort to increase the assets in the bankruptcy estate and shift the burden on those creditors and suppliers to demonstrate that their transaction was not a preference.

How to deal with a preference action, what constitutes “ordinary course of business” and what’s an insider are more complicated questions that should be discussed with an experienced bankruptcy attorney.

Fraudulent Conveyance:

Contrary to a preference, a fraudulent conveyance (or fraudulent transfer) is all about the debtor and its intent or actions.  Did the debtor make the transfer with the “actual intention to hinder, delay or defraud” any creditor of the debtor?  A classic example might be where a debtor gives away valuable property to a family member or other insider as a way to keep the asset away from creditors.

However, under both bankruptcy and New York law, a trustee can avoid a fraudulent conveyance even if the debtor has no fraudulent intent. The trustee just needs to show a transfer for less than fair consideration at time debtor was insolvent or debtor made insolvent by transfer.  An example might be where a debtor filing (perhaps without a bankruptcy attorney) is a little too generous in giving away valuable assets to a family member without awareness of the impact on their subsequent bankruptcy filing.

It’s also worth noting that a fraudulent conveyance action (as opposed to a preference action) can be initiated by a trustee as well as by a creditor.

Blog by Rosenberg Musso & Weiner

In BFP v. Resolution Tr. Corp., 511 U.S. 531 (1994), the Supreme Court held that a mortgage foreclosure sale conducted in accordance with state law was shielded from avoidance under the Bankruptcy Code’s fraudulent conveyance provision, 11 U.S.C. § 548.

In re Adeeb 787 F.2d 1339 (1986) Our conclusion is consistent with cases interpreting “concealed” as used in section 727(a)(2)(A). Those cases state that a “debtor who fully discloses his property transactions at the first meeting of creditors is not fraudulently concealing property from his creditors.” In re Waddle, 29 B.R. 100, 103 (Bankr.W.D.Ky.1983); see 4 Collier on Bankruptcy ¶ 727.02[6][b] (15th ed. 1985). Although a concealment may be undone simply by disclosing the existence of the property, disclosure does not undo a transfer. However, a transfer may be undone by recovering the property.

We conclude that a debtor who transfers property within one year of bankruptcy with the intent penalized by section 727(a)(2)(A) may not be denied discharge of his debts if he reveals the transfers to his creditors, recovers substantially all of the property before he files his bankruptcy petition, and is otherwise qualified for a discharge.


In re Stern, No. 00-56431 (9th Cir. 02/04/2003) Feb. 6, 2003
TRANSFER OF ASSETS INTO EXEMPT PROFIT-SHARING RETIREMENT PLAN ON EVE OF BANKRUPTCY WAS NOT FRAUDULENT David A. Gill, Bankruptcy Trustee (“Trustee”), appeals the district court’s decision affirming the bankruptcy court’s order, which granted summary judgment in favor of the debtor Steven Stern (“Stern”). Stern cross-appeals the district court’s determination that Stern’s pension plan funds are not excluded from the bankruptcy estate.

Stern filed for bankruptcy after the entry of a sizeable judgment against him in an arbitration proceeding. We must determine whether the transfer of proceeds from an Individual Retirement Account (“IRA”) into a Profit Sharing Pension Plan was a fraudulent conveyance, subject to avoidance by the Trustee.

Constrained by our precedent, we AFFIRM the district court’s holding that, although the pension plan was properly included within the bankruptcy estate, the pension plan assets were exempt from distribution to Stern’s creditors.

In 1978, Stern terminated the 1974 Plan and created a qualified, defined benefit pension plan (“1978 Plan”). In 1989, Stern terminated the 1978 Plan and transferred the plan assets into an IRA account (“IRA”).

We are controlled by our prior opinion in Wudrick v. Clements, 451 F.2d 988 (9th Cir. 1971). In that case, we ruled “that the purposeful conversion of nonexempt assets to exempt assets on the eve of bankruptcy is not fraudulent per se.” In reversing the district court’s determination that Wudrick engaged in a fraudulent conveyance, we clarified that “[t]he finding of fraud was based solely on the fact that nonexempt assets were deliberately converted to exempt assets just prior to filing the bankruptcy petition.” Id. at 990. We explained that this “evidence was insufficient as a matter of law to establish fraud.” Id. Our analysis was impliedly affected by the clarification that a different conclusion might be reached “if on the eve of bankruptcy a debt were created with no intention of repaying the creditor . . . .” We also noted that a finding of fraud must be established by “clear and convincing” evidence.

Property divided pursuant to divorce decree and fraudulent transfer issue:

In re Beverly , 374 B.R. 221 (9th Cir.BAP 2007) affirmed in part, dismissed in part by In re Beverly, 551 F.3d 1092 (9th Cir. 2008). BAP reversed the Bankruptcy Court by finding that Debtor and his former wife committed fraudulent transfers. Their divorce decree awarded the debt to the future Bankrupt while the former wife got all of the non-exempt property. The non-exempt property would have been enough to satisfy all of the debt. Contrast with In re Bledsoe,569 F. 3d 1106 (9thCir 2009) where the Court of Appeals found that the mere allegation that the property settlement of divorce decree did fairly divide property was insufficient under §548 without proof of actual fraud.

Zazzali v. United States (In re DBSI, Inc.), 2017 U.S. App. LEXIS 16817 (9th Cir. Aug. 31, 2017)  Avoiding a fraudulent transfer to the Internal Revenue Service (“IRS”) in bankruptcy has become easier, or at least clearer, as a result of a unanimous decision by the Ninth Circuit Court of Appeals.

Merit Management Group, LP v. FTI Consulting, Inc. (US Supreme Court 2/27/18) The key issue in the case was the scope of Section 546(e) of the bankruptcy code which insulates certain transactions from a bankruptcy trustee’s statutory avoidance powers.

The transfer at issue involved an agreement to purchase the stock of a proposed harness racing business for $55 million. The funds necessary to complete the transaction were placed in escrow at Citizens Bank, and later disbursed to the sellers’ equity holders, including Merit Management, which received $16.5 million pursuant to the terms of the sale contract. The buyer quickly failed and filed for Chapter 11 bankruptcy. FTI Consulting was appointed as trustee under a litigation trust established pursuant to a Chapter 11 plan. FTI sued Merit to recover the payment made, arguing that the value of the stock received by the debtor in the transaction was not reasonably equivalent to the amounts paid. In defense, Merit asserted that Section 546(e) provided a safe harbor because it received funds, not from the debtor, but from Citizens Bank – a financial institution.

The District Court concluded that Section 546(e) barred recovery of the transfer, but the Seventh Circuit reversed and the Supreme Court granted certiorari to determine the scope of the limitation and unanimously ruled that Section 546(e) did not shield Merit.

Payments your business received from a customer that later files for bankruptcy.  The following is part II of an article by Ashley Dillman Bruce.

Your business now faces an adversary complaint filed by the bankruptcy trustee. The complaint has several counts alleging that your business received fraudulent transfers of assets from a debtor in bankruptcy. The complaint alleges two types of fraudulent transfers. The first is actual fraud, which involves a debtor’s intent to delay, hinder, or defraud its creditors. The second is referred to as constructive fraud, which involves a debtor’s transfer of assets made in exchange for inadequate consideration.

Type of Transferee

Your business may have defenses available to a claim of either actual or constructive fraud. The first step in analyzing what defenses are available is to determine what type of transferee you are. An “initial transferee” is one who receives the fraudulently-transferred funds directly from the debtor. If your business is the “initial transferee,” then as the recipient of the transfer, your business bears the burden of proving that it gave value to the debtor and received the property in good faith. If your business did not receive the transfer directly from the debtor, then the business would be a “mediate” or “subsequent” transferee, and in this instance, your business bears the burden of proving that it received the property in good faith. Determining what type of transferee your business is determines what it must prove to defeat a trustee’s claim – good faith and value if an initial transferee, or just good faith for a mediate or subsequent transferee.

Good Faith

In either instance, your business will have to prove that it received the transfer in good faith. Good faith is judged using an objective standard, where a court will look to what your business objectively “knew or should have known” rather than examining what it actually knew from a subjective standpoint. If the circumstances would place a reasonable person or entity on inquiry of a debtor’s fraudulent purpose, and diligent inquiry would have discovered the fraudulent purpose, then the transferee may be found to have not acted in good faith.

Value

If your business was the initial transferee, then it will have to prove that it also provided value to the debtor in exchange for the transfer. The Bankruptcy Code and Florida Statutes provide that value is given for a transfer or an obligation if, in exchange for the transfer or obligation, property is transferred, or an antecedent debt is secured or satisfied. In determining whether a debtor received reasonably equivalent value, the essential examination is a comparison of “what went out” with “what was received.”

Mere Conduit

There is case law in the Eleventh Circuit that has developed around the meaning of “initial transferee.” In examining what “initial transferee” means, courts have developed an exception known as the mere conduit or control test. This exception is asserted as an affirmative defense where an initial recipient of a transfer, usually a bank or escrow agent, actually received the transfer but is legally not an “initial transferee” because that party has no control over the fraudulently-transferred funds. Under the Eleventh Circuit precedent, to satisfy the mere conduit test, a party would need to lack control over the funds, i.e., that the party merely served as a conduit for the assets that were under the actual control of the debtor-transferor.

CONCLUSION

If your business is facing a demand made by a bankruptcy trustee or has been served with a complaint seeking to avoid transfers as fraudulent, it is important to understand any possible defenses that are available. Knowing your rights under the Bankruptcy Code is key to protecting your property.

Blog by Berger Singerman LLP – Ashley Dillman Bruce

New York Federal Court Holds County Tax Foreclosure May Constitute Fraudulent Conveyance

The United States District Court for the Western District of New York recently reversed a Bankruptcy Court’s dismissal of an action and held that sales arising from tax foreclosures may be avoidable as fraudulent transfers. See Hampton v. Ontario Cty., New York, 2018 WL 3454688 (W.D.N.Y. July 18, 2018). The case involves two adversary proceedings commenced by homeowners against the County of Ontario (the “County”). In each matter, the County foreclosed on plaintiffs’ homes after plaintiffs failed to pay property taxes. In one case the plaintiffs owed about $1,200 in taxes and in the other they owed about $5,200. After the County obtained a final judgment in each matter, the plaintiff homeowners filed Chapter 13 bankruptcy petitions and then adversary proceedings against the County, alleging that the taking of their homes were constructively fraudulent transfers under 11 U.S.C. § 548(a)(1)(B) due to the disparity between the value of the homes and the minimal taxes owed. The County proceeded to sell the properties—one for $22,000 and one for $27,000—under a stipulation that the sales were subject to the determination in the adversary proceedings. The County moved to dismiss the actions, and the Bankruptcy Court granted the motion. In doing so, it cited BFP v. Resolution Trust Corp., 511 U.S. 531 (1994), where the United States Supreme Court held that a reasonably equivalent value for foreclosed property “is the price in fact received at the foreclosure sale, so long as all the requirements of the State’s foreclosure law have been complied with[.]”.

On appeal, the District Court reversed. First, it noted that the Supreme Court in BFP expressly limited its holding to mortgage foreclosures, stating that “considerations bearing upon other foreclosures and forced sales (to satisfy tax liens, for example) may be different.” Second, the Court found that the amount of the tax lien is not evidence of the property value and that the sales would result in windfalls to the County because it would receive all of the surplus funds to the detriment of other creditors. “If this Court affirmed the Bankruptcy Court’s decision, Ontario County would receive surpluses of nearly $22,000 in one instance and more than $20,000 in another. The Appellants, on the other hand, assert that they would be homeless and unable to repay their other creditors through Chapter 13 bankruptcy.” Thus, the Court reinstated the adversary proceedings against the County.

DeGiacomo v. Sacred Heart University (In re Palladino) (1st Cir. Nov. 11, 2019), a First Circuit appellate panel held that parents do not receive “reasonably equivalent value” when they make tuition payments to a college or university on behalf of an adult child. The court noted that the Bankruptcy Code recognizes five classes of transactions that confer value: (1) the exchange of property, (2) the satisfaction of a present debt, (3) the satisfaction of an antecedent debt, (4) the securing or collateralizing of a present debt, and (5) the granting of security for the purposes of securing antecedent debt. While the Palladino Court recognized that a parent’s funding of a child’s tuition might be a worthy cause and an appropriate expenditure for a solvent person, the payments depleted the estate and afforded no direct value to creditors. The court found that funding an adult child’s tuition payments, even with an expectation of future financial support, does not satisfy requirements for a “reasonably equivalent value” defense under the Bankruptcy Code. Additionally, the court noted that the debtors were not under any legal obligation to pay college tuition for their adult children, suggesting in a footnote that the outcome may be different in the case of tuition payments for a minor child. In so holding, the First Circuit has validated tuition clawback lawsuits against colleges and universities.  See original article


Two courts have added to the murky case law addressing a bankruptcy trustee’s ability to recover a debtor’s tuition payments for their children. In Geltzer v. Oberlin College, et al., 2018 WL 6333588 (Bankr. S.D.N.Y. Dec. 4, 2018), a New York Bankruptcy Judge permitted a trustee to claw back payments that parents made to their financially independent adult children for college-related costs. In Pergament v. Brooklyn Law School, et al., 2018 WL 6182502 (E.D.N.Y. Nov. 27, 2018), a District Court held that schools may assert a “good faith” defense for tuition payments received before the student enrolls in classes, but not those payments received after the student has enrolled.   See original article


Geltzer v. Oberlin College (In re Sterman), 18-01015 (Bankr. S.D.N.Y. Dec. 4, 2018) On an issue dividing the lower courts, Bankruptcy Judge Martin Glenn of New York squarely held that educational expenses paid for a child over the age of majority are constructively fraudulent transfers, assuming the debtor-parent was insolvent (New York age of majority is 21).

Conversely, Judge Glenn found no fraudulent transfer in his December 4 opinion when parents paid educational expenses for a minor child, because parents receive reasonably equivalent value by satisfying their obligations to educate their children.

Whitlock v. Lowe (In re DeBerry), 18-50335 (5th Cir. Dec. 23, 2019) Circuit Judge Ruled that the recipient of a fraudulent transfer cannot be tagged with a judgment if the transferee has retransferred the property to the debtor, even if the debtor “frittered the money away” before bankruptcy. Whatever the theory, Judge Oldham said that a “bankruptcy trustee cannot ‘recover’ property that the transferee returned to the debtor before the bankruptcy filing.”

In re Brown, 18-60029, (9th Cir Ct App, BAP No 17-1068, March 23, 2020). The Ninth Circuit affirmed the bankruptcy court and the Bankruptcy Appellate Panel’s ruling in favor of a Chapter 7 trustee who contended that funds fraudulently transferred by the debtor remained property of the bankruptcy estate upon conversion from Chapter 13 to Chapter 7. Under 11 U.S.C. § 348(f)(1)(A), upon conversion, the converted estate consists of the assets that remain in the possession or control of the debtor at the time of conversion. Here, the debtor made unauthorized and fraudulent transfers of funds during the Chapter 13 proceeding. The Circuit held that, because the debtor transferred the funds with the fraudulent purpose of avoiding payments to creditors, the funds remained within his constructive possession or control, and hence should be considered part of the converted estate.

In re Carlo Bondanelli BAP No. CC-19-1175-TaFS (9th Circuit, Mar 18,2020) Not Published Ruling:BAP for 9th Cir. affirmed ruling of bankruptcy court (CD Cal.) approving chapter 7 trustee’s settlement of fraudulent transfer action against debtor’s investment company over strenuous creditors’ objection. Settlement was fair and equitable. Creditors’ opposition was a factor that court properly considered, but creditors do not have veto power of settlements.